Clubbing of income in context of the Income Tax Act (ITA), is when the income of a person is not taxed in that person’s hands but instead is included (added) to another person’s income for tax purposes. For example, any income arising out of gift given to the spouse in included (only for tax purposes) in the income of the donor spouse. Similarly, the income that arises or accrues to the minor child is included (for tax purposes) in the income of that parent whose total income is greater.

Now the question that arises is whether such income is to be clubbed on a gross basis prior to giving effect to tax deductions or on a net after deduction basis – in fact this was the very issue that the Kolkata Tribunal Bench had to take a decision on (Deputy Commissioner of Income-tax v Rajeev Goyal & Others, IT Appeal Nos. 951 & 963 (Kol.) of 2011) The brief facts of the case were that the taxpayer Mr Shankar Sharma had earned taxable long term capital gain (LTCG) from sale of shares of around Rs 5.50 crore. Similarly, his minor daughter earned LTCG of around Rs 49.70 lakh while his minor son earned LTCG of Rs 39.50 lakh. Mr Sharma invested Rs 50 lakh in Sec. 54EC bonds issued by REC while his daughter and son invested their entire capital gain amount in such bonds. The Assessing Officer (AO) clubbed the LTCG earned by the minor children in the assessee’s hands but limited deduction under Sec. 54EC only to investment of Rs 50 lakh in assessee’s name and did not allow deduction for investment in REC bonds made by his minor children citing the investment limit of Rs 50 lakh imposed by the proviso to section 54EC(1).

Aggrieved, the assessee preferred appeal before CIT(A), who in fact allowed the claim of assessee and deleted the disallowance. In turn, the Revenue Department appealed to the Tribunal. The Revenue’s stand was that the benefit of deduction is available to an assessee and in the present case there was only one assessable entity being the individual Shri Shankar Sharma. His children, being minors could not be termed as independent assessees or persons and their income is only clubbed in the hands of the main assessee.  On the other hand, counsel for the taxpayer argued that the word ‘person’ has been defined in section 2(31) of the ITA which includes an individual and there cannot be any dispute that minor children are individuals separate from the parent. After hearing rival submissions, the Bench ruled in favour of the assessee. It held that even though a minor’s income is clubbed under Sec. 64(1) of the ITA in the hands of his parents, he / she is to be considered separate than his parents.

The clubbing provisions of the ITA as detailed in Sec. 64(1A) specify that in computing the total income of any individual, there shall be included all such income as arises or accrues to his minor child. The word ‘such’ means the total income of the minor, because ‘such’ is preceded by the words total income. Further the words ‘total income’ have been defined under Sec. 2(45) of the ITA to mean the total amount of income as computed in the manner laid down in the Act. The Bench also quoted the decision of the Bangalore Bench of the ITAT in the case of Bajaj Ashok Chunnilal, wherein it is held that – “Considering all the aforesaid decisions it can be held that unless and until the income of the minor child is computed, the clubbing provision will not apply.” Further, Mumbai Bench of the Tribunal in the case of Smt. Babita P. Kanungo, had held – “From the above, we find that in computing total income of an assessee, all such income as arises or accrues to his minor child is to be clubbed. The words “all such income” in this section refer to total income and we are of the considered opinion that for giving effect to this section, first the total income of the minor children is to be computed and then such total income only of the minor children is to be clubbed with the income of the parent.”

Quoting a few other decisions, the Bench concluded by finally relying on the case of of Segu Harnath, wherein the Hon’ble A.P. High Court had held “Where the assessee was a partner in a firm and his minor daughter was admitted to the benefit of partnership in the firm and assessee borrowed funds and invested the same in the partnership firm in the name of his minor daughter, the interest payable by the assessee on capital borrowed by the assessee on behalf of the minor daughter was deductible under section 67(3) from the share income arising to the minor child and it was only the resultant income, after deduction which was to be included in the total income of the assessee under section 64(1) (iii)”.
The Kolkata Bench opined that the above judgment clearly showed that even if the income of the minor is clubbed with the income of the parent, all the deductions are to be allowed while computation of income of the minor and only the net taxable income is to be clubbed under section 64. In view of the above, the claim of the assessee was allowed and the AO was directed to recompute the long term capital gains accordingly.

To sum
The underlying principle in the above case may be equally applied for cases where income of the spouse is to be clubbed with that of the other spouse. With the sheer number of judgments that exist on this matter, whether the income to be clubbed is on a gross or a net basis is clearly not a settled issue. To save money, time and resources of all stakeholders concerned, perhaps the authorities should consider inserting an Explanation to Sec. 64(1A) specifying that clubbing with apply only to net income after considering all available tax deductions. This will once and for all remove all ambiguity.The authors may be contacted at wonderlandconsultants@yahoo.com

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